Polaris Industries: Growth & Dividends at a Reasonable Price

Published by Eli Inkrot on August 6th, 2016

The average population may not be too familiar with Minnesota-based Polaris Industries (PII). Dividend investors should familiarize themselves with the company. Here’s why”

First, Polaris is a Dividend Achiever — one of 274 stocks with 10+ consecutive years of dividend growth. Click here to see all 274 Dividend Achievers.

As this article will show, Polaris has produced phenomenal growth over the last decade. The company is currently trading for a price-to-earnings ratio of 16.5. Polaris is an example of a shareholder friendly business with strong growth trading at a reasonable price — that’s difficult to find in today’s market.

If you ever happen to be stuck in the snowy backwoods of Maine you’ll be glad that the company exists. Here’s a description the business per the company’s website:

“For millions of people around the world, Polaris has become synonymous with adventure and passion, in both work and play. For more than 60 years, we’ve been making high-quality, breakthrough products — whether it’s launching the snowmobile industry, reinventing ATV categories year after year, developing the first purpose-built military vehicles or introducing a radical 3-wheel moto-roadster.”
“From our entrepreneurial roots as a mechanical shop, we’ve grown into one of the world’s largest Powersports companies. And in recent years, we’ve expanded beyond Powersports into adjacent markets, like commercial and military vehicles, where we can add value. Today, Polaris offers a diverse portfolio of best-in-class brands.”

Here’s what that looks like in visual form:

Source: Polaris Industries

Of particular note has been Polaris’ rise as of late. A decade ago, companies like Honda and Harley were much more dominant in the Powersports arena, with Polaris on par with names like Yamaha and Kawasaki. Today Polaris leads the pack:

Source: Polaris 2016 Investor Presentation

It’s not one of those products that you absolutely “need” (unless that happens to be your primary source of transportation) but the company has been doing quite well for some time. Here’s a look at the business and investment performance from 2006 through 2015:

In a business sense, this is what “taking off like a rocket” looks like. Had you owned shares back in 2006, you could have simply held on as the company would explode growth-wise.

On the top-line Polaris grew revenues by over 12% per annum, increasing from about $1.7 billion in 2006 to $4.7 billion by 2015. By itself, this is quite impressive. However, this very strong top-line growth was further supplemented by two additional factors.

For one thing you had a strong increase in net profit margins — from 6.8% all the way up to 9.6%. Not only was Polaris generating substantially more sales, but the quality of those sales as measured by profitability was increasing as well. This allowed company-wide profit growth to approach 17% per annum.

If the number of common shares outstanding remained the same during this period, an investors ownership claim growth would be equal to the company-wide profit growth. For Polaris this was not the case. The number of outstanding shares went from 83 million down to 65 million, resulting in earnings-per-share growth that approached 20% per annum.

When you have 20% annual earnings growth over a prolonged period, you don’t need a whole lot to go right valuation-wise for things to turn out well. You could see something trade at say 50 times earnings and compress down to 20, as an example, but otherwise the strong business results tend to propel strong investor returns.

With Polaris you had a security that began the period trading around 17 times before coming down closer to 13 times earnings last year. So there was a “valuation drag,” but not insofar as to greatly dampen shareholder gains. Shareholders would have seen capital appreciation alone of nearly 16% per annum.

The dividend component is also an interesting tidbit of Polaris’ investing past. The dividend grew rather nicely over this period — over 14% per year — but this was still slower than the very impressive 20% annual EPS growth. As such, the payout ratio actually declined — going from around 45% of profits down closer to 30%. It’s not often you see 14% annual dividend growth coupled with a declining payout ratio.

The starting yield was around 2.5%, so the dividend did add nicely to an investors overall return. Put together, investors would have seen total annualized compound gains on the magnitude of 17% per annum. As a point of reference, that’s the sort of thing that would turn a $10,000 starting investment into $41,000 or so after nine years. Clearly long-term investors have fared well.

And by the way, this is actually even more impressive than it first appears. Had the measuring period been through the end of 2014 instead, the returns would have been even more exceptional. Polaris has seen its share price nearly halved in the last couple of years.

Which, incidentally, is why the security may look more interesting today as compared to say two years ago. A fast growing company trading around 25 times earnings may be interesting, but it doesn’t exactly tick the “value” box. Alternatively, a company with the potential for fast growth trading at 14 or 15 times earnings becomes a bit more compelling. This is the current situation for Polaris.

And to be sure, there are reasons for this now much lower valuation. Instead of the quite robust growth that many have been accustomed to seeing, 2016 is actually expected to be a down year. Here’s the guidance that the company provided in its most recent presentation:

Source: Polaris Investor Presentations

In 2015 the company earned $6.75. Now that number is expected to be closer to $6.00 to $6.30 a share. Lofty valuations tend to be reserved for solid growth, so it makes sense that as profitability slows (and in this case declines) the valuation multiple would decline as well. However, a year or three of decline does not necessitate that the company can never grow again.

Indeed, per share earnings declined nearly 20% from 2005 to 2006 — a much greater decline than what is expected today — just prior to the above observation period whereby the business and shares performed spectacularly. Naturally that doesn’t mean it will happen again, but it does show that a down year is not the end of an investment thesis.

With that in mind, let’s think about what a future scenario could look like. Here’s a hypothetical set of assumptions for the next 10 years:

The middle column displays the same historical information as above for reference. The right-hand column shows a hypothetical situation. On the top-line a much subdued 5% annual revenue growth assumption is used, as compared to a history of over 12% in the past. Moreover, margins are presumed to decline a bit, reflecting the continued stiff competition in the industry.

Instead of nearly 17% company-wide profit growth, here we’re looking at growth of just over 4%. The share repurchase program had been quite effective in the past, and with a lower rather than higher payout ratio (and valuation) you might suspect that this repurchase program can continue to be effective. Put together this equates to an annual earnings-per-share growth expectation of just under 7%.

As a point of reference, analysts are presently anticipating something closer to 13% yearly growth over the intermediate-term, so the above presumption doesn’t appear overly optimistic. Granted if the company stops growing altogether, either assumption will be too high, but the point is that the above stance is well below what is anticipated by those that follow the company on a daily basis.

From there, you have two drivers that can aid in a shareholder’s total return: valuation and dividends. The current valuation is a touch below the historical average, while you have a well-covered and solid dividend with a propensity to grow. Put together, using much subdued anticipations, you might expect the security to generate 9% average compound gains. Obviously this doesn’t have to occur, but it does provide a baseline.

This is how I’d begin to think about an investment in Polaris. Naturally there’s a bit more to it than that, but the above illustration provides a reasonable framework for further investigation.

Polaris has demonstrated an exceptional investment past due to strong revenue growth, margin improvement, a reduced share count and a growing dividend. Moving forward revenue growth and margin expansion may be more difficult to formulate, but the repurchase program and dividend can still complement the business nicely.

Polaris combination of growth, a shareholder friendly management, and a reasonable valuation give the company an above-average rank using The 8 Rules of Dividend Investing.

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